The wholesale ‘financialization’ of ‘developed’ economies over recent decades has brought us a world in which nearly every spot market has a financial market correlate. It has also brought, via the price-volatility and associated short-termism that financialization encourages, productive atrophy and deindustrialization to these same economies: ‘investment’ dollars for decades have flowed more toward speculative betting on price swings in secondary and tertiary financial and derivatives markets, and less toward productive-capacity-building in primary markets.
After a decades -long slumber, erstwhile ‘developed’ economies appear at long last to be noticing the dysfunctions that untrammeled financialization has wrought. Socio-political volatility stemming from long-term deindustrialization and associated income- and wealth-skewing, and vital supply-chain disruptions stemming more recently from pandemic, are spurring efforts to ‘build back better,’ ‘greeinfy’ obsolescent technologies and infrastructures, and restore some semblance of citizen control over nation-states’ economies.
These productive revitalization efforts, along with geopolitical developments rooted therein, are now finding expression in the monetary realm. In so doing, they are rendering more prices than money rental (a.k.a. ‘interest’) rates, and more supply inputs even than foodstuffs and fuelstuffs (mainly but not solely grains and petroleum), what I long ago christened ‘systemically important prices and indices (SIPIs).’
The upshot, I argue in a recent paper, is that we shall soon have to marry our public liquidity reserves (a.k.a. ‘central banks’), which modulate money supplies to collar prices generally, with our public commodity reserves (a.k.a. ‘strategic stockpiles’), which modulate staples supplies to collar prices more particularly.
Let me explain that in brief…
Public liquidity reserves act to modulate one obvious systemically important price: viz. the aforementioned interest rates. They collar these prices, in turn, ‘Goldilocks’ style – not too high, not to low – by modulating supplies: money supplies.
Public commodity reserves do something similar: they modulate supplies of systemically important materials to collar their systemically important prices.
We tend not to notice the role of commodity reserves when supplies are abundant and prices are correspondingly stable – as they were for most of the ‘real’ economy’s ‘Great Moderation’ of recent decades, at least in the U.S. and its peer nations.
Until recently, accordingly, commodity reserves’ stability-maintenance role had gone largely forgotten for decades. Steady supplies on the ‘real’ side of the economy during that ‘Great Moderation’ kept prices within bounds. Our strategic reserves’ supply modulation activities were thus less salient than were those of the central banks, then seeking to stabilize anything but ‘moderate’ financial markets.
Another cause of our having forgotten strategic reserves in recent decades is that, via a strange sort of regulatory counterpart to financialization itself, we have for decades been treating all price problems as central bank problems, forgetting the mutual interactions of supplies with prices. This was in keeping, of course, with a more general forgetfulness about the central importance of production itself.
Recent developments, however, have rendered this reduction, and with it our present division of ‘reserve’-keeping labor, no longer tenable.
On the liquidity reserve side of the divide, supplies and production are once again salient. And with them more prices become salient – at least in a monetary exchange economy like our own. That makes Federal Reserve operations more complex and difficult. Whether it fully appreciates the point or not, it now must specifically consider the prices of all critical inputs to production, not just of ‘goods and services’ generically conceived.
Meanwhile the same financialization that obscured and undercut production for decades, which largely occurred during the ‘real’ economy’s putative ‘Great Moderation,’ has made it more difficult for our commodity reserves to do their job too. For the spot markets in which these reserves operate have morphed into a ‘dog’ that’s now largely ‘wagged’ by the ‘tail’ of financialization’s chief offspring: the derivatives markets.
The upshot is obvious: just as financialization has now integrated our spot and derivatives markets, so must we now integrate the operations of our price- and supply-modulating public reserves operating within those markets. We must partly merge, in other words, Federal Reserve operations with our commodity reserves’ operations. This will be needed to keep both supplies and their price correlates collared – what the Federal Reserve Act and counterpart central bank mandates call ‘stable.’
Central banks and strategic stockpiling agencies will accordingly no longer be able to operate ‘on separate tracks’ in isolation from one another. They will have to conjoin or coordinate their financial and spot market operations in the name of combined price and supply stability in respect of all critical inputs and prices. As the world re-polarizes and developed economies repudiate post-, and embrace now post-post-, industrialization, this need will grow ever more clear and compelling.
The object of the price and supply interventions that I predict won’t be ‘price controls.’ Rather, it will be price- and supply-pushes, in market-contrarian manners, by macroprudentially authorized instrumentalities working to collar supply and price volatility rooted more in hedging and sheer speculative activity than in supply- and demand- ‘fundamentals’: rooted, that is, more in what the 19th century political economists would have called ‘exchange values’ than in ‘use values.’
The object, in other words, will be to maintain stable background conditions as is (a) requisite to long-term planning, hence productive incentives, on the part of private sector market agents; (b) now imperiled as never before in the past 80 years by geopolitical tectonic-shifting, and (c) mandated by most central bank enabling legislation.
This was all destined, I think, more or less inevitably to come to pass. And it’s helpful to understand this if one is to understand why what I propose here is no mere ad hoc response to a temporary problem. For what I propose is the unavoidable culmination of an evolutionary process to whose endpoint we have been stumbling with dim awareness for decades now.
Central banks are, again, originally liquidity reserves. The Fed’s name reveals it. Commodity reserves are for their part essential staples reserves.
Liquidity reserves become necessary adjuncts to commodity reserves only as a generic exchange economy takes on the more specific form of a monetary exchange economy. When the latter occurs, what the political economists called exchange values – a.k.a. ‘prices’ – can get out of sync with their underlying use values, thereby distorting production and consumption decisions by misleading deciders as to what’s really wanted and what’s really available. Call this ‘the First Divergence.’
This divergence becomes all the more perilous as a monetary exchange economy becomes a ‘financialized’ economy, in which real productive inputs and consumption goods take on not only monetized lives as ‘input and consumption good prices,’ but also financialized lives as contingent claim (a.k.a. ‘derivative’) prices. Markets become objects of ‘meta-markets,’ which in time become objects of ‘meta-meta-markets,’ and so on, as what I call market stratification continues apace.
As this process unfolds, the use-value/exchange-value gaps of the First Divergence can be ‘levered’ to absurd proportions at which prices lose any discernible anchor at all in anything long-term or fundamental, thereby separating people, through (secondary and tertiary market) prices, unbridgably both from their own products and from the very means of biological survival. Call this ‘the Second Divergence.’
Central banks as liquidity reserves are well suited to handling the First Divergence. Central banks whose mandates are magnified into more general ‘macroprudential’ or ‘financial stability’ mandates in turn are well suited to handling the Second Divergence.
But these gambits – central banks as liquidity reserves and as macro-modulators – work only under two conjoined conditions. First, their leaderships must understand these mandates, as, for example, the post-1935 US Fed certainly did not until recently and still only dimly discerns. (Witness Greenspan’s position during the ‘Lean versus Clean’ Debate just over a decade ago.)
And second, they must coordinate their activities with those of the commodity reserves from which they evolved and to whose functions they remain nearly always and everywhere functionally tied – a requirement that cannot be understood till the first requirement is met.
The paper I mentioned attempts to facilitate that understanding.
It first reprises the notion of ‘systemically important prices and indices’ (SIPIs), which I introduced over a decade ago. We have long recognized one such price and accordingly authorized one instrumentality to ‘target’ it – money rental, a.k.a. ‘interest,’ rates – targeted by Fed open market operations. My argument is that interest rates are now far from alone.
Moreover, I argue, certain commodity prices are more systemically important even than many other such SIPIs, rivaling even home prices in the magnitude and ubiquity of their influence.
The paper next turns to the financial practice of collaring – in essence, the retention of price fluctuations within stable bands. I note that New York Fed open market operations are collaring operations, and argue that such operations are now needed in multiple additional markets.
Against this backdrop, I highlight the signal importance of the Chicago Fed’s now opening a trading floor on Wacker Drive next to the Chicago Mercantile Exchange (CME, a.k.a. ‘Merc’) – the world’s primary commodity derivatives market – analogous to the New York Fed’s trading desk just off of Wall Street. I emphasize commodity prices in particular in this connection, and indicate how the FRBC can rationally and transparently set the requisite commodity price collars.
The paper then pivots to strategic stockpiling agencies such as the US Department of Agriculture’s (USDA’s) Commodity Credit Corporation (CCC) and the US Department of Energy’s (USDOE’s) Strategic Petroleum Reserve (SPR). These will have to coordinate closely with the Federal Reserve Bank of Chicago (FRBC, or again, Chicago Fed’) in light of both (a) derivative prices’ links to supplies in commodity markets, and relatedly (b) the fact that commodity derivatives traders must have at least some capacity to make and take delivery of commodities as adjuncts of their derivative trading activities.
These and related entities both in the US and elsewhere, I argue, are accordingly no longer mere ‘rainy day funds.’ They are destined to become critical supply-collaring entities just as the Fed and its counterparts are, complementarily, price-collaring entities. That will be, moreover, a return to historical practice – indeed even pre-monetary, ancient historical practice.
These reserves must not now, however, be run separately from central banks, I then argue. For, first, the derivatives exposures that the central banks must now undertake necessitate some complementary delivery -making and -taking capacity in associated spot markets – the stockpiling agencies’ bailiwick, as argued earlier. And, second, the supply-modulating function of the latter, in turn, is far easier to manage if paired up with counterpart price-collaring in the derivatives markets by central banks.
In this sense, I reinforce, from the supply side, my earlier arguments in respect of the price side of the ‘marriage’ that I am here urging.
I then consolidate the foregoing reflections and hazard predictions concerning the seemingly ever more rapidly crystalizing future. The world appears, I suggest, to be entering a new axial period involving great geopolitical competitions for newly needed industries and industrial resources, as well as associated domestic supply and price stability, worldwide. If that is right, then my arguments are not only timely, but apt to require updating at least quarterly.